Ares Commercial Real Estate Corp quarterly report, Q3 FY2022

Ares Commercial Real Estate Corporation — Q3 2022 Form 10-Q Summary

Business Context and Reporting Period

Ares Commercial Real Estate Corporation is an externally managed REIT and specialty finance company focused on originating and investing in commercial real estate loans and related investments. The filing covers the quarter and nine months ended September 30, 2022, and was filed November 2, 2022.

Key Financial Metrics

Metric	Q3 2022	Q3 2021	9M 2022	9M 2021
Total revenue	$27.3 million	$27.2 million	$76.4 million	$72.0 million
Net interest margin	$27.3 million	$21.4 million	$73.8 million	$59.7 million
Net income attributable to common stockholders	$0.6 million	$10.0 million	$26.9 million	$43.3 million
Diluted EPS	$0.01	$0.21	$0.52	$1.05
Dividends declared per share	$0.35	$0.35	$1.05	$1.05
Net cash provided by operating activities	—	—	$42.1 million	$30.3 million

Q3 2022 net income represented approximately 2.4% of revenue, compared with approximately 36.6% in Q3 2021. The nine-month net income margin was approximately 35.2%, compared with approximately 60.2% in the prior-year period.

Assets were $2.73 billion at September 30, 2022, compared with $2.63 billion at December 31, 2021.
Loans held for investment were $2.51 billion before the $46.1 million funded-loan CECL reserve, compared with $2.41 billion at year-end 2021.
The loan portfolio comprised 70 loans with $2.53 billion of outstanding principal and a weighted average unleveraged effective yield of 7.8% on accruing loans.
Cash and cash equivalents were $77.3 million at September 30, 2022. As of November 1, 2022, management reported approximately $156 million of liquidity, consisting of $81 million of unrestricted cash and $75 million of secured-funding availability.
Financing Agreements had $1.10 billion outstanding against $1.54 billion of total commitments. Consolidated CLO securitization debt was $822.3 million.
Total liabilities were $1.96 billion and stockholders’ equity was $767.1 million. Management stated that all Financing Agreement financial covenants were satisfied at September 30, 2022.

Material Changes Versus Prior Comparable Period

Interest income increased 34% in Q3 and 23% for the first nine months, primarily reflecting larger earning assets, higher LIBOR and SOFR, hedging benefits, and accelerated recognition of fees and prepayment penalties.
Interest expense increased to $18.4 million in Q3 from $12.7 million and to $43.9 million for nine months from $35.9 million, reflecting higher borrowings and rising rates.
Provision for current expected credit losses increased to $19.5 million in Q3 from $6.4 million and to $26.7 million for nine months, compared with a $0.8 million benefit in the prior-year period. Management attributed the increase to rising inflation, rapidly increasing interest rates, geopolitical uncertainty, COVID-19 effects and portfolio changes.
Net income declined substantially despite higher net interest margin because of the increased CECL provision and higher operating costs. The prior-year period also benefited from hotel operations, whereas the hotel property was sold on March 1, 2022.
The company raised approximately $103.2 million net from a May 2022 offering of 7.0 million common shares. Shares outstanding increased to 54.4 million at September 30, 2022 from 47.1 million at December 31, 2021.
The company originated or acquired several CRE loans and purchased three AAA-rated CRE debt securities during Q3. It also entered into a $105 million SOFR-based note financing secured by a $133 million multifamily mortgage loan.
The MetLife Facility was extended to August 2023, and the company exercised an extension of the CNB Facility to March 2023. The Wells Fargo Facility had an initial maturity date of December 14, 2022, subject to extensions.

Guidance, Outlook, Risks and Unusual Items

Management expects primary liquidity sources to be sufficient to fund operating activities and cash commitments for at least the next 12 months, while noting that this expectation depends on financing availability, borrower payments and market conditions.
The company currently expects leverage not to exceed 4.5-to-1 debt-to-equity, although its charter and bylaws do not restrict leverage.
The Board declared a fourth-quarter 2022 dividend of $0.35 per share, consisting of a regular $0.33 dividend and a supplemental $0.02 dividend, payable January 18, 2023.
Credit risk increased: three loans with a carrying value of $100.8 million were on non-accrual status. A $14.3 million California residential loan was in maturity default and received a specific $2.4 million CECL reserve. A $30.2 million Illinois hotel loan was also on non-accrual status and in default for failure to make certain reserve deposits, although contractual interest payments were current.
Total CECL reserves were $51.9 million, including $46.1 million against funded loans and $5.8 million for unfunded commitments. The reserve equaled 186 basis points of total loan commitments.
Key risks include higher interest rates, inflation, recession, credit deterioration, declining commercial real estate values, refinancing and maturity risk, margin calls, funding availability, CLO overcollateralization tests, prepayment and extension risk, LIBOR-to-SOFR transition, COVID-19 effects and geopolitical disruption.
The hotel property sale generated a $2.2 million gain for the nine months. No real estate-owned revenue or expense was recorded in Q3 2022.
The company adopted an amended and restated management agreement in July 2022. Management and incentive fees totaled $3.9 million in Q3 and $10.6 million for the first nine months.
No material pending legal proceedings were reported. Disclosure controls were assessed as effective, and no material changes in internal control were reported.

Important Facts for Investors to Verify

Whether the elevated CECL reserve and non-accrual loans result in additional losses, restructurings or collateral realizations.
The status and extension terms of the Wells Fargo Facility and other secured funding arrangements approaching maturity.
Actual liquidity after considering $257.9 million of unfunded loan commitments, margin-call exposure and CLO cash-flow restrictions.
Whether rising benchmark rates continue to expand net interest margin or instead increase borrower defaults and financing costs.
The sustainability of the $0.35 quarterly dividend relative to Core Earnings, taxable income, cash flow and required REIT distributions.
The impact of the May 2022 equity issuance, management fees and the $50 million authorized stock repurchase program on per-share returns.